India is a vast country with states as large as European nations. States are internally very diverse in terms of culture, language and geography. A large number of problems are best settled at the local level, where people have better knowledge of local issues and can directly participate in decision making. Therefore, the need for a third tier of government — below the Central and State governments — was recognised in the Constitution to enable effective local self-government.
Source: Decentralisation in India, Chapter 2
The examiner expects two clear points: (1) the reason — India's vast size and internal diversity making two-tier governance insufficient, and (2) the rationale — local problems are best solved locally with direct public participation. Avoid writing about Panchayati Raj amendments (1992) unless asked separately, as that addresses steps taken, not why the need was recognised.